ESG Regulation and Policies and Their Implications for Companies

There has been a rise in ESG (Environmental, Social, and Governance) regulations and policies, aiming to regulate the actions, reporting, or disclosures related to the environment, society, and overall governance.

According to the World Business Council for Sustainable Development’s (WBCSD) Reporting Exchange Platform, there are more than 2,400 ESG regulations covering more than 80 jurisdictions worldwide, all of which are updated in real time. This represents an increase of 155% in the past decade, with 1,255 ESG regulations introduced worldwide since 2011.

Most of these regulations are attempting to align themselves with the more dominant industry standards that businesses are complying with. These include the Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI), Task Force on Climate-Related Financial Disclosures (TCFD), and Sustainable Finance Disclosure Regulation (SFDR).

From the 80 jurisdictions worldwide, this article explores in more detail the ESG regulations of the following jurisdictions: European Union (EU), US, UAE, India, and Israel.

European Union

The EU is leading the ESG-regulated framework worldwide, having introduced several regulations concerning ESG:

• Taxonomy Regulation;

• Non-Financial Reporting Directive (NFRD);

• Corporate Sustainability Reporting Directive (CSRD);

• Sustainable Finance Disclosure Regulation (SFDR);

• Corporate Sustainability Due Diligence Directive (CSDDD).

• Taxonomy Regulation

The Taxonomy Regulation, which entered into force on 12 July 2020, is a green classification system that translates the EU’s climate and environmental objectives into criteria for specific economic activities for investment purposes.

The Taxonomy Regulation positively recognises green, or “environmentally sustainable”, economic activities that make a substantial contribution to achieving the following six climate and environmental objectives, while meeting minimum social safeguards:

1. Climate change mitigation

2. Climate change adaptation

3. Sustainable use and protection of water and marine resources

4. Transition to the circular economy

5. Pollution prevention and control

6. Protection and restoration of biodiversity and ecosystems

It is a transparency tool that introduces mandatory reporting obligations on some companies and investors, requiring them to disclose their share of taxonomy-aligned activities, allowing for the comparison of companies and investment portfolios.

The overall taxonomy framework consists of:

The Taxonomy Regulation
The delegated act with assessment criteria for the first two environmental objectives
The delegated act on transparency obligations

This is supplemented by further delegated acts on:

Gas/atoms
Assessment criteria for the other four environmental objectives
A social taxonomy
In addition, the taxonomy reflects transition efforts by companies – “transition finance”.

The delegated act on the first two environmental objectives will be extended to include activities such as agriculture.

In 2023, in accordance with Article 10(4) of the Disclosures Delegated Act, large non-financial undertakings will need to report activities that are considered aligned with the EU Climate Delegated Act. Similarly, and in accordance with Article 10(5) of the Disclosures Delegated Act, large financial institutions should disclose their taxonomy-eligible and aligned activities in 2024 for activities related to climate objectives.

Non-Financial Reporting Directive

Under the Non-Financial Reporting Directive (NFRD) (Directive 2014/95/EU), certain large EU public-interest companies must disclose non-financial and diversity information in their annual reports. This information relates to the following ESG areas:

environmental protection
social responsibility and treatment of employees
respect for human rights
anti-corruption and anti-bribery
and diversity on company boards

Large public-interest corporations are defined as companies with more than 500 employees, including insurance companies.

According to the EU Taxonomy, companies falling within the scope of the existing NFRD – approximately 11,700 EU companies – are expected to report on the extent to which their activities are sustainable, as specified in the relevant Commission Delegated Act, in alignment with Sustainable Finance Disclosure Regulation (SFDR) and existing EU Taxonomy requirements.

Sustainable Finance Disclosure Regulation

The Sustainable Finance Disclosure Regulation (SFDR) aims to enhance transparency in the sustainable investment market. Its purpose is to prevent misleading environmental claims – also known as “greenwashing” – against investment products and to increase investment into sustainable products to accelerate the transition to a low-carbon economy.

The SFDR mandates that investment products be categorised into three distinct groups based on their degree of sustainability and related features. Additionally, financial market participants who are now subject to these regulations are required to comply with specific disclosure obligations.

The SFDR requirements are linked with those under the EU Taxonomy by including environmentally sustainable economic activities as defined by the Taxonomy Regulation in the definition of “sustainable investments” in the SFDR.

The SFDR came into effect in March 2021. Since then, financial market participants and financial advisers have been expected to disclose:

Sustainability risks policy.
Integration of sustainability risks into investment decisions and investment advice.
Principal adverse impacts (PAI) of investment decisions on sustainability factors at the entity level (or an explanation of no consideration of PAI at the entity level)
Consistency of remuneration policies with the integration of sustainability risk.

The Corporate Sustainability Reporting Directive

The Corporate Sustainability Reporting Directive (CSRD) broadens the existing applicable NFRD and looks to address key structural weaknesses in current ESG regulation reporting. The new regulation affects a higher number of large EU-listed entities than the NFRD, including businesses, banks, and insurance companies, with approximately 50,000 entities impacted by the CSRD, almost five times as many as the previous NFRD legislation.

Each company within scope is required to report more broadly on sustainability-focused topics, including environmental matters, social responsibility, respect for human rights, anti-corruption measures, and board diversity. Entities also need to report on how environmental and social matters influence their development – this is called “double materiality”.

Companies that meet two of the following three conditions must comply with the CSRD:

More than €40 million in net turnover
Balance sheet total assets are greater than €20 million
250 or more employees

In addition, non-EU companies with a turnover of at least €150 million in the EU over two consecutive years must comply.

The new rules will apply for the first time in the financial year 2024 for reports that will be published in 2025. The CSRD will cover all listed companies in EU-regulated markets (except listed micro-enterprises).

European Sustainability Reporting Standards (ESRS)

The European Sustainability Reporting Standards (ESRS) set out detailed reporting requirements for EU companies in the scope of the CSRD, including EU subsidiaries of non-EU companies.

On July 31, 2023, the European Commission adopted the first set of ESRS. The ESRS soon will become law and will apply directly in all 27 EU member states, but not in the UK. Companies will need to report in compliance with these new ESRS as early as the 2024 reporting period.

The standards are notable for their breadth and granularity, going well beyond the reporting requirements in other mandatory and voluntary ESG reporting frameworks. Companies in scope need to start getting ready to report to these new ESRS now.

The ESRS cover:

General reporting principles.
A list of mandatory disclosure requirements for EU companies related to the identification and governance of sustainability matters.
The 10 ESG topics where disclosure is required, are subject to a materiality assessment.

While this is the first set of ESRS, further sets of standards also will be adopted in the near future for specific industry sectors, small and medium-sized enterprises (SMEs), and non-EU parent companies.

Together, the CSRD and ESRS require companies to:

Perform materiality assessments on each sustainability topic applying the double materiality principle to work out which information should be reported. (In line with double materiality, companies must report if sustainability information is material from either a financial or an impact perspective, taking account of people and the environment.).

Report on the material impacts, risks, and opportunities (IROs) identified in the company’s own operations, those of its group, and those of its upstream and downstream value chain.